Flexible Spending Accounts: How New Rules Help You, Hurt Drugstores

New rules on flexible spending accounts let you hold onto some of your unspent money, but they could hurt Rite Aid, Walgreen, and CVS Caremark.

Taking advantage of all your employee benefits is a smart move, and many people use flexible spending accounts to save on taxes for their health-care spending. A recent change will make medical flexible spending accounts much more attractive, but it could come at the expense of Walgreen (NASDAQ:WBA), Rite Aid (NYSE:RAD), and CVS Caremark (NYSE:CVS), as well as other retailers and health-care professionals that count on year-end flex-account spending to boost their profits. Let's take a closer look at flexible spending accounts, and how the new rules affect you and the health-care industry.

How flexible spending accounts can save you hundreds Medical flexible spending accounts are employer-sponsored plans that allow you to put money toward health-care expenses. Contributions from your paycheck are made on a pre-tax basis, saving you not only income tax, but also payroll taxes on the amount you put into your FSA. As long as you spend your money on qualified medical expenses, you don't pay any tax or penalty when you withdraw it. With the rules letting you contribute up to $2,500 toward a medical flexible spending account, the total income and payroll tax savings can add up to hundreds of dollars. An estimated 14 million workers use medical FSAs.

Historically, the big downside of flexible spending accounts was that they had a "use it or lose it" rule, whereby if you didn't spend the money you put in your FSA for a given year, you forfeited it. That led many people not to participate in FSAs, or to put less money than they otherwise would have contributed into their accounts.

But now, the U.S. Treasury changed its requirements. Now, employers will be able to allow employees to carry forward up to $500 into the following year. The Treasury said that changes can take effect immediately in the 2013 plan year, but employers have to elect to participate.

The end of an era?What's good news for workers, though, is bad news for the health-care industry. When participants had to spend their flexible spending account balances, it led to substantial amounts of year-end spending. December specials at optometrists' offices, and retailers of prescription eyeglasses, took advantage of workers trying to spend down their FSA balances before they lost their money. As employers adopt the new rule, though, workers will have less incentive to spend down their unused balances, hurting those businesses.

It's hard to separate the impact of the rule at drugstores, especially since many employers now offer grace periods that can extend into the following year. Still, Rite Aid reported higher average sales during December than in November last year, and although CVS doesn't report monthly sales figures, Walgreen saw revenue rise 15% last December compared to the previous month.

This isn't the first time that the industry has had to deal with FSA rule changes. Beginning in 2011, workers could no longer use flexible spending account money for many over-the-counter drugs or medicines without a prescription. There were several exceptions, such as contact lens solution, but the change was substantial enough to raise concerns at major health-care companies.

Use it and don't lose itBear in mind, though, that if your employer doesn't take action, the new rules won't automatically apply to your flexible spending account. Be sure to check with your HR department to find out what rules apply, and whether they'll take effect this year or next. Ideally, though, the rule changes should make it easier for you to use flexible spending accounts to save on your taxes.

Tune in to Fool.com for Dan's regular columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
Follow @DanCaplinger